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  "documentTitle": "Rail industry cost and revenue sharing (2011)",
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  "authorName": "L.E.K.",
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  "notes": "Discusses RPI-X regulation, capex/opex reclassification risks, and ORR/NR/TOC incentive alignment.",
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      "text": "One of the ORR's objectives for the cost and revenue sharing mechanism is to encourage TOCs to engage more constructively with them during the periodic review process.",
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      "text": "A similar type of arrangement could be used as part of a cost and revenue sharing mechanism in order to incentivise TOCs to seek NR cost reductions irrespective of the stage in the control period. However, this would make the mechanism more complicated and would lead to management time being devoted to an activity that is non-value adding from the rail industry's perspective",
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      "text": "The ORR has adopted a similar mechanism for NR, except that NR is only allowed to keep 25% of the underspend. As a result, NR has an even greater incentive to classify costs as capex",
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      "text": "One of the ORR's objectives for the cost and revenue sharing mechanism is to encourage TOCs to engage more constructively with them during the periodic review process. However, if the ORR determination is used as the baseline then TOCs would have a perverse incentive to encourage the ORR to set an easily achievable baseline. They would try to convince the ORR that NR needs to carry out a large volume of work and that it has already achieved a high level of efficiency",
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      "text": "this mechanism has led to a significant amount of management time being devoted to reclassifying opex as capex, because companies are allowed to retain 100% of the opex savings",
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      "text": "In the early years of RPI-X type regulation the incentive to achieve efficiency gains reduced towards the end of each control period. Companies responded to this lack of incentive by not implementing changes in those years",
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      "text": "In response, the regulators introduced balancing mechanisms to ensure that companies get a fixed proportion of the underspend from any year regardless of when the efficiency occurs",
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      "text": "This perverse incentive could be counteracted by giving TOCs a partial exposure to the ORR's periodic review determinations (i.e. Options 5 and 6)",
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      "text": "In most regulated sectors companies are allowed to keep c.40% of any efficiently incurred capex underspend for 5 years. This is implemented through an increase in the RAB balance at the start of the next control period",
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      "text": "3 – Baseline: A mechanism may also be required to incentivise efficiency improvements across control periods. Furthermore, TOCs could be incentivised to side with NR during periodic reviews",
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